With the recent prevalence of the Internet, buying and selling goods, services, and financial instruments across international boarders have become increasingly common. Such buying and selling is typically referred to as conducting “e-commerce.” In practice, e-commerce (electronic commerce) and a newer term, e-business, are often used interchangably. E-commerce can be divided into several categories, including “e-tailing” and business-to-business (B2B) buying and selling.
For example, e-tailing (or “virtual storefronts”) are located on World Wide Web sites along with online catalogs. Many virtual storefronts can form a “virtual mall.” As a place for direct retail shopping, with its 24-hour availability, a global reach, the ability to interact and provide custom information and ordering, and multimedia prospects, the Web is rapidly becoming a multibillion dollar source of revenue for the world's businesses. For example, as early as the middle of 1997, Dell Computers reported orders of a million dollars a day. By early 1999, projected e-commerce revenues for business were in the billions of dollars and the stocks of companies deemed most adept at e-commerce were skyrocketing. Although many so-called “dotcom” retailers disappeared in the economic shakeout of 2000, Web retailing at sites such as Yahoo.com, Amazon.com, CDNow.com, and CompudataOnline.com continues to grow.
In addition, thousands of companies that sell products to other companies have discovered that the Web provides not only a 24-hour-a-day showcase for their products but a quick way to reach the right people in a company for more information. This is known as business-to-business buying and selling.
As a result of global e-commerce, buyers and sellers often transact business between countries. Accordingly, foreign currency exchange comes into play. However, the value of currency (the currency rate) for each country continuously varies, so there is never a set foreign exchange rate. As a simple example, a purchaser may be from the U.S., while a vendor may be from Europe. If the vendor accepts U.S. currency, the vendor will have to be concerned with the fluctuation of the U.S. dollar vis-á-vis the Euro. More generally, a vendor will need to exchange received foreign currency to the currency that the vendor uses in his accounting, regardless of the country where he resides. Of course, the country of the vendor typically coincides with the currency used in his accounting.
Consider the case where Yahoo! Italy posts prices in Euros, presumably because the users of Yahoo! Italy reside in Italy or an European Community country. To the extent that another currency is displayed (say U.S. dollars), the conversion rates will likely not represent current market rates. Assume that the current foreign exchange rate for the Euro is $0.89 U.S.==C 1 Euro. However, a Yahoo! tee-shirt is being sold for either $15 U.S. or 13.55 Euro. This implies that $1.107==C1 Euro, which will be assumed to have been the exchange rate when Yahoo! originally posted its price for the subject tee-shirts. The proper price of the tee-shirt, given current rate, would be either $12.06 and =C13.55, or $15.00 and =C16.85. However, the exchange rate used by Yahoo! is stale, as the Euro lost value to the U.S. dollar.
As illustrated above, vendors who sell goods and services in a variety of currencies are vulnerable to stale foreign exchange rates. If Yahoo! sells 100,000 tee-shirts in Europe at =C13.55 Euro, and exchanges the Euro into U.S. dollars at the market exchange rate, then they will have incurred a loss of $3 per tee shirt ($300,000 total) due to stale foreign exchange rates. Accordingly, to limit its foreign exchange exposure, the vendor may periodically sell its foreign currency in exchange for its own currency. This is referred to as foreign exchange “hedging.” When and how much to foreign currency to exchange at any time may be decided by the vendor's hedging policies or rules.
To facilitate foreign exchange transactions, vendors and purchasers create credit relationships with one or more foreign exchange (FX) rate providers. A FX rate provider can give the purchaser or vendor an update of the current exchange rate, and conduct the exchange transaction. Generally, vendors and purchasers trade in foreign exchange with said rate providers over the telephone or over the Internet.
Vendors have a number of different approaches towards managing and hedging their foreign exchange exposure including, but not limited to: individual transaction hedging; aggregated transaction hedging; and average or baseline rate hedging. Of course, hedging may include any combination of the above, as well as more sophisticated methods of hedging.
Individual transaction hedging is simply hedging on a transaction-per-transaction basis. Aggregated transaction hedging is based on time intervals (i.e. daily, weekly, monthly, etc.) or based on a notional amount (e.g., hedge every $100,000 worth of transactions). Average or baseline rate hedging allows the vendor to net its foreign exchange risks across revenue and expense streams. In this case, the vendor's accounting personnel (i.e., its treasury group) will manage the foreign exchange exposure and hedge the net risk.
However, conventionally the hedging transactions are conducted in separate mediums from the underlying purchase or sale transactions. In other words, purchasers and sellers of the goods and services transact in the foreign currency and subsequently hedge their foreign exchange exposure separately. Alternatively, they may use services, such as those provided by credit cards, that automatically convert the currency for the purchaser.
There are many shortcomings in the current landscape of global e-commerce. For example, in some instances the purchasers do not have access to all vendors because of the above described barriers related to foreign currency exchange. In other instances, the purchasers can only transact in foreign currency and have no means, or at best inefficient means, available to them for hedging. Credit Card purchases are a perfect example. The purchaser is not made aware of the foreign exchange rate, i.e., the cost of the goods in their “home” currency, until after the transaction has been completed.
Whether hedging occurs on a transaction-by-transaction basis, aggregate basis, or by any other means, given the technology available today, the only solution is to transact the foreign exchange hedge independently from the underlying purchase or sale of goods. Separate scripts need to be written in order to automate the feed, of the underlying transaction details and of the foreign exchange transaction details, into the operational systems that rely on this information (e.g., accounting systems and inventory systems).
FIG. 1 shows a schematic representing an example of an e-commerce transaction and an independent foreign exchange hedging transaction. Assume for FIG. 1 that S (a seller of widgets) operates in currency $. B (a buyer) operates in currency =C. B goes to S's website to buy 1000 widgets. B only has a =C bank account. S has a preferred FX rate provider 5 which offers =C/$ trading capability. S also has a “nostro” bank 58, where S holds nostro accounts in both =C and $. A nostro account is a foreign currency current account that is used to receive and pay currency assets and liabilities potentially denominated in a currency other than that of the country in which the bank is resident. Assume at the time of the transaction, the foreign exchange is =C1.1=$1.
In Step 10, S's treasury department 18 monitors the foreign exchange market and the transaction flow from its website 28 independently from each other. In Step 20, the treasury department 18 intermittently updates the foreign selling price of goods on S's website 28, based on the market exchange rate. In Step 30, S displays the prices of his widgets in =C, which B views on his computer 38. In Step 40, B purchases 1000 widgets. The transaction record is passed to the treasury department 18 at Step 50. In Step 60, B instructs his bank 48 to pay =C1,100 to S's bank 58. B's bank 48 pays =C1,100 to S's nostro bank 58 at Step 70. At this point, this transaction has been processed and aggregated with past transactions. The treasury department decides if and when a hedging foreign exchange transaction is required. If they decide to execute a foreign exchange transaction, Steps 80 through 110 occur as follows.
In Step 80, an instruction is sent from the treasury department 18 to S's chosen FX rate provider 5. The rate provider 5 then executes a foreign exchange transaction with S's nostro bank 58. Specifically, S's =C =Caccount at nostro bank 58 pays =C1,100 to the rate provider 5 at Step 90. In Step 100, S's chosen rate provider 5 pays $1,000 to S's $ account at nostro bank 58. Lastly, in Step 110, an FX confirmation is sent to S's operations department 68.
One problem with the above transaction is that the seller's treasury department may not be disciplined, competent or efficient enough to accurately, and in a timely fashion, reflect changes in the FX market rates. Further, risks also stem from the loose, non-automated coupling of e-commerce transactions to the corresponding FX hedges. Business rules concerning hedge criteria are applied with a significant manual effort. This often leads to errors and may encourage intentional misapplication of the seller's business rules.